Andrew Needham looks at when to opt to tax a property for VAT purposes and when it is not necessary.
If a business is renting or selling a commercial property it will be making an exempt supply (unless it is selling a commercial property less than three years old, in which case it is automatically standard rated).
If it makes exempt supplies it cannot recover any of the associated VAT (subject to the de-minimis limits).
Opting to tax
The only way to avoid this input tax restriction is to opt to tax the property. By doing this, it turns an exempt supply into a standard rated taxable supply. It can then reclaim the VAT on any costs relating to the property, but it has to charge VAT on the rent or sale of the property.
If it is a property rental business, it therefore makes sense to opt to tax its properties so it can reduce its costs by being able to recover the associated VAT. Most businesses are registered for VAT and will be able to recover the VAT on their rents.
What is not covered?
The option to tax (OTT) only applies to commercial property or bare land; it never applies to residential property. This means that residential property rental remains exempt from VAT and a business can’t recover any associated input tax.
If a business has a mixed use building, for example shops on the ground floor and flats above, the option to tax only applies to the commercial ground floor. The rental of the flats remains exempt and input tax relating to the residential parts of the property cannot be reclaimed.
If a business converts an opted commercial property into residential use the option to tax no longer applies.
When doesn’t a business need to OTT?
If a business buys a property that it trades from there is no need to opt to tax it in order to reclaim the VAT on its purchase. The reason for this is simple; it is not making supplies of the property, but making supplies from the property.
The business therefore looks at what supplies it makes to decide if it can recover any VAT relating to the purchase or maintenance of the property.
A normal taxable business can recover the VAT on the purchase and maintenance of the property based on the taxable status of the business, and there is no need to opt to tax.
Can a business opt to tax later?
If a business owns or rents a property, it can opt to tax it at any time, not just when it first occupies it.
It may be the case that when the business first occupies the property there is no need to opt to tax it, but subsequently it decides it is beneficial to do so, it can then opt to tax it at that later date.
Example: Tenant sub-letting part of property
A manufacturing business rents a property. The landlord has opted to tax it. It therefore charges VAT on the rent, which the tenant recovers as it is fully taxable.
After five years, the tenant decides to rent out part of the property to a sub-tenant. This means that it is now making an exempt supply of property rental (the landlords option does not pass down to the tenant) so it would have to restrict a proportion of the input tax it pays on the rent.
The tenant can therefore opt to tax its interest in the property at that stage, charge VAT on the rent to the sub-tenant, and there is no restriction on the input tax that it can claim on the rent from the landlord.
A business only needs to opt to tax if it is renting or selling a commercial property. If it trades from a property there is no need to opt to tax in order to recover the VAT on costs associated with it